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Shale and Petroleum – The Big Picture (Part 1)

Shale and Petroluem - The Big PictureBack in the mid-to-late ‘80s, when Dennis Miller had a massive mullet (and his stand-up performances were much more likely to be attended by you and your friends than your distant aunt and uncle who worked on the ’72 Nixon campaign), his “Weekend Update” features on Saturday Night Live were often enriched by little segments featuring writer and comedian A. Whitney Brown, who, with just the right amounts of sarcasm, compassion, wit, and insight, would give us “The Big Picture.” In these editorials, Brown shared his perceptions about the topics of the day, suggesting that we take a step back and look at things with a bit more perspective than found in the prevailing media narrative. Well, now that we’ve discussed in previous articles on this site the woes of Connacher, the credit troubles of certain shale oil producers, the risks and the tax advantages of investing in oil exploration master limited partnerships, and how the strong companies of the sector are still buying up heavy production equipment even in this market, it’s time to take a step back and look at the big picture—beyond the bankruptcies, the price volatility, and the analyst forecasts for various companies. What exactly is our global circumstance when it comes to oil and gas, and how should that information shape our understanding of the current, short-term, and long-term market?

There’s a lot to consider, no doubt, as there are many players on the world stage. We have Iran, Russia, and Venezuela acting as three key producers who have major conflicting interests with the U.S. Then there’s Iraq, where the U.S.-led war, incursions from ISIS, the ongoing sectarian violence, and lackluster showing as a beacon of democracy in the Middle East do not bode well. There are new technologies allowing us to extract oil from deep under the sea, and even from certain rocks and sands. Saudi Arabia, a close U.S. ally, is apparently now flexing its muscle as the predominant member of OPEC, establishing policies that benefit itself and a few other members to the detriment of numerous others. All the while, a collection of scientists and activists tries to keep us focused on vital environmental protections that industry simply has little motivation to concern itself with.

But these are all merely different players in this great theatre spectacle of the Age of Oil. The playwright who has written this script, and has called these actors to the stage, is a much maligned, dreaded, and misunderstood figure. We most commonly refer to it, when we do at all, as Peak Oil. It is Peak Oil that is feeding these actors new lines from the side of the stage as it gauges audience reactions, and it is Peak Oil that will tell them all when to bow at the curtain call.

If you’re overly enthusiastic or dismayed about where this conversation is going, please hold for a bit — it is quite likely that you have yet to examine the pertinent facts outside of the context of an inflammatory discussion designed to either put you in fear of a coming apocalypse or get you to laugh off the whole issue as the latest paranoid ramblings of so many modern-day Chicken Littles. There’s been a lot of hype by both supporters and detractors of Peak Oil, so let’s walk through this step by step, define our terms, and try to keep the focus on what we absolutely do know about the limits to continued growth in the global daily average production of conventional oil. We should also look at how the inevitable effects of those limits have been mitigated by the rather recent introduction of unconventional oil (like shale and tar sands) into the markets.

In this first installment of a three-part series, I’ll be focusing on the front side of this equation—the limits to the growth of conventional (i.e., less expensive) oil production.

“All the easy oil and gas in the world has pretty much been found. Now comes the harder work in finding and producing oil from more challenging environments and work areas.” Not my words—these are those of William J. Cummings, spokesperson for Exxon-Mobil company. From 10 years ago. Now, listen to Lord Ron Oxburgh, former chairman of Shell, from 2008: “It is pretty clear that there is not much chance of finding any significant quantity of new cheap oil. Any new or unconventional oil is going to be expensive.” That should perk up your ears if you weren’t already aware of it.

These statements provide a good lead-in to understanding Peak Oil, but to get the full picture let’s go back to the beginning. About 65 years ago, at mid-century, a geoscientist associated with Shell named M. King Hubbert noted that the production output of conventional oil from every individual oil rig, and every geographical area, tended to follow a bell-shaped curve. From the initial discovery of a source, the production increase starts out gradual and then morphs into an exponential up-tick until reaching a peak. The peak does not take an immediate about-face, but rather levels as a plateau, during which production remains fairly flat for a time. After this, production declines in a similarly-shaped downward curve, never to return. There are a number of contributing factors that cause this, but it’s simplest to remember that at a certain point in the life of a well, when about half its underlying oil has been extracted, it becomes more difficult, and thus also more expensive, to extract the remainder. As the well runs lower, the volume of oil that can be produced per day drops. Eventually, there is no longer any value in trying to extract the remaining oil and the well is abandoned.

This was a fairly obvious observation which anyone looking at the data at the same time as Hubbert could have made. The novel idea that Hubbert introduced was to project this phenomenon outward and arrive at the striking conclusion that since all these wells and individual areas are following production curves, then by logic the production of every country, and the world as a whole, should also follow such curves. Thus, every country will reach a peak in its production, and the world as a whole will also reach a peak.

That world peak in conventional oil production is what is generally meant by “Peak Oil”—it refers to that point in time in which the volume of production no longer continues its upward trajectory, and then subsequently goes into an irreversible decline. Hubbert’s work, and in fact all discussions of oil supplies from the time he was first ridiculed until fairly recently, have concerned themselves only with conventional oil, and so “Peak Oil” still continues to be used as a term referencing global production of conventional crude oil, i.e., petroleum—that fossil fuel substance under the ground that already exists in liquid form. It is not a question of the world “running out of oil,” as a popular straw-man argument goes, but a question of not being able to expand the production volume of this cheap, conventional oil. Similar production peaks will no doubt come in relation to unconventional sources[1], such as shale and tar sands, but we need to address each in their own silo first before we can get a good grasp of “the big picture.”

As mentioned above, production peaks of conventional oil first come to a plateau, a time in which production is fairly stable—no more skyrocketing growth, but no significant decline. The beginning of that plateau is the “peak,” strictly speaking, and any upward spike of production from that peak only represents the expected irregular shape of the plateau. It does not invalidate the peak or indicate a return to significant upward growth. The plateau, though not necessarily a straight line, is essentially the ceiling that has been hit. We can consider this as Stage 1. Stage 2 comes when the plateau gives out and the production starts following the downward part of the bell curve. Plateaus can last a varying length of time, but they tend to be in a range that does not disrupt the general bell curve shape; when the plateau is reached, the beginning of the downward slope is never far behind.

Hubbert predicted that the peak of U.S. oil production would occur by 1970, and, strictly speaking, his prediction held true (as regards conventional oil production from the 48 contiguous states), with the U.S. peaking in the early 1970s. He predicted world production would peak around the turn of the century, and many have found an uncanny accuracy in that prediction as well.

For some years, Peak Oil proponents have pointed to Ghawar as the “canary-in-a-coal-mine” for Peak Oil. No, I’m not talking about Gwar, the shock-rock thrash metal band from my home town, Richmond, Virginia[2], but the Ghawar oil field in Saudi Arabia, which is by far the largest single field of petroleum in the world. Nothing approaching the size of Ghawar has ever been found, and extensive searches on the planet have confirmed that no others exist. Like a General Motors for oil, “as Ghawar goes, so goes . . .” the whole of world production. Guess what? Many experts believe that Ghawar has peaked in production, notwithstanding unsubstantiated protestations by the Saudis to the contrary. This would undoubtedly mean a peak has been reached in Saudi production, and by extension a peak in world production.

But let’s just assume for argument’s sake that Ghawar has a lot of life left in it before it goes into decline. Does that change the situation? Well, unfortunately, no. There simply haven’t been enough discoveries of conventional oil to sufficiently replace the undeniable peaks that have been reached in other production areas. For those who understand this, the patronizing statements of “don’t worry, we’ll find it” ring hollow. It would have been found already. Most of the top 50 oil producing countries in the world are already in undeniable decline, and quite a few have peaked in the last 10 years. These production peaks have great negative impacts on the economies of those countries. You can be assured that there is no great conspiracy by them to deliberately produce less oil.

It’s useful to understand that production peaks and discovery peaks are directly related. U.S. discoveries peaked in the late 1930s, and the production peak came around 40 years later. As for world oil, discoveries peaked in the 1960s and have been declining since—this is indisputable. Not even overblown estimates of reserves that are subsequently downgraded, or which spuriously include figures for oil that is known to not be recoverable, have been able to paint a different picture. Thus, a peak of world production has been considered inevitable, and given a similar 40-year-spread from peak discovery would likely have occurred in recent years. (Reminder: we are still only discussing petroleum, i.e., conventional oil, at this point.) This is why the general consensus is that the peak of conventional oil will take place between 2015 and 2025 (2030 by the most optimistic). These dates were actually pushed back later from earlier accepted dates because unconventional sources were brought online and relieved some of the pressure to produce conventional oil.

Make no mistake: it is well settled that the end of the continued increase in global production of cheap, conventional oil is upon us.

In Part 2 of this series on shale and petroleum, I’ll address the newly exploited unconventional oil sources (the production of which has not yet peaked) and how these new, more expensive sources of oil minimize the impact of reaching the limits to growth in conventional oil, while not eliminating that impact entirely. Then in Part 3 we will review the short- and long-term benefits to unconventional oil as well as the other macroeconomic factors that will continue to influence the oil market for many years to come.

[1] Although not nearly enough data is available now to predict exactly how the production curves will be shaped for these types of resources.

[2] In the news around this time last year when lead singer and founding member Dave Brockie died of a heroin overdose, after 30-years in the band.

About Brad Daniel

Brad Daniel is a Director at BMC Group, an information management firm specializing in financial and legal transaction support. He has 25 years of restructuring experience, with a broad exposure to all aspects of bankruptcy case administration and reorganized-company/trustee support. His expertise in both bankruptcy legal matters as well as systems integration and rapid application development…

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Brad Daniel